The Severn Company: Balance Sheet as of December 31, 2001 (Millions of Dollars)
Current assets$ 900.00Accounts payable$ 172.50Net ﬁxed assets450.00Notes payable to bank255.00Other current liabilities225.00
Total current liabilities$ 652.50
Long-term debt (10%)300.00
Common stock, $3 par60.00
Total assets$1,350.00Total liabilities and equity$1,350.00
The Severn Company: Income Statement for Year Ended December 31, 2001(Millions of Dollars)
Operating costs2,227.50Earnings before interest and taxes (10%)$ 247.50Interest on short-term debt15.00
Interest on long-term debt30.00Earnings before taxes$ 202.50
Federal-plus-state taxes (40%)81.00
Net income$ 121.50The probability distribution for annual sales is as follows:
ANNUAL SALES PROBABILITY(MILLIONS OF DOLLARS)
Assuming that EBIT is equal to 10 percent of sales, calculate earnings per share under both the debt ﬁnancing and the stock ﬁnancing alternatives at each possible level ofsales. Then calculate expected earnings per share and EPS under both debt and stock ﬁnancing alternatives.
Also, calculate the debt ratio and the times-interest-earned (TIE)ratio at the expected sales level under each alternative. The old debt will remain out-standing.
Which ﬁnancing method do you recommend?
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